What you need to know about Basel III Endgame

Q&A with Heitmeyer’s Senior Director Advisory & Consulting Service, Robin Collins.

Give us a quick rundown on your experience.

I worked in about every area banking you can think of for 35 years. Some of my favorite areas would be leading teams in lending, engineering, project management, payments, treasury, M&A, really just involved in a bit of everything.

I spent over twenty years with Regions Bank and another eleven with BBVA and worked on some really exciting initiatives with both.

At Regions we handled a merger with AmSouth and we did a lot to make that transition successful. Typically, when banks merge, you see an uptick in unposted numbers for a variety of reasons. Two banks have different numbering structures, new teams are collaborating, things like that. But we actually saw a reduction in unposted deposits, and we were able to lower credit unposted by around 97%. We were doing some really exciting things over there.

Q: Since joining Heitmeyer in December, what projects have you been excited about?

A: One of the things I’m most excited about helping is bringing in some more standardization and organization around what ACS is doing. That area is experiencing some really fast growth and companies need to take time to get that organized.

Q: What is Basel III Endgame?

A: Endgame is a series of proposed modifications to Basel III requirements. I think they’re trying to ensure-and this came out before the SVB closure- that banks will have stronger self-capital structures leading to less risk and failure potential. SVB failed because of liquidity problems. Customers started pulling their money out over fears of a collapse which made the liquidity problems worse. These adjustments will make things more expensive for banks to lend. These impacts will be felt especially by lower income and less qualified individuals. Banks will have to keep cash on hand for credit lines, so customers with large credit lines that are unused might have those reduced or closed. They could also just up annual fees or interest on these lines.

Q: On that note, what shifts do you see for private credit lines?

A: I think what we’re going to see is less qualified individuals are going to receive credit at much higher rates, or they’re not going to get a loan at all. Banks could even drop these services for existing customers.

Q: Banks can adjust credit lines without warning?

A: Yes. Banks need to shift costs to keep revenue up, and it’s going to cost them to keep cash on hand as collateral for large, unused credit lines. All of a sudden, a customer can get a letter in the mail and their line is reduced just like that. Customer education and communication will be key. A bank that previously allowed someone to have a 30K credit line open, in which they never used more than 10K, could suddenly decide to lower that limit. How that communication is delivered can be the difference between an understanding consumer and an upset consumer.

Q: Will this apply to home and commercial lending?

A: One of the biggest things is that, right now, if a borrower can’t afford a mortgage, they can restructure terms so they can. That means banks don’t hold these on their books as being a bad asset. Endgame would change this classification. It will forever be a bad asset. This would be a big negative effect on smaller banks that specialize in mortgages.

Q: Are there a good chunk of regional banks that specialize in this?

A: A lot of banks will initiate loans to get the initial fees and then turn around and sell the servicing to Fannie Mae, Freddie Mac, something like that. Some banks are more flexible and may keep it on the books, retaining individuals who look unqualified on paper. Maybe you’re self-employed, make good money, but don’t have a W2 or show a loss every year. These wouldn’t qualify to be passed off to a third party and the bank can keep them on their books instead. With these adjustments, you may see the banks allowing less of that.

Again, this is going to cost the banks more to do something like this. They’re either going to pass the expenses onto the consumer, or just not give out the loan at all.

Q: How could this affect first time buyers?

A: The vast majority of the impact will be felt by lower and moderate-income consumers. It’s going to be harder and more expensive. One of the things Endgame does is look at your risk weighting using things like LTV value. The higher your LTV, the higher the risk rating, the more expensive that loan will be. Banks will be much more selective. They might turn away from low percentage down loans, and say they’re only doing 10-20% down loans. It’s going to hurt banks but hurt people more.

Now these are the proposed rules, not the final rules. I expect that after the open feedback period enough people have raised concerns  to create some changes. A big thing not talked about is the international aspects. This is going to make it harder for US banks to compete with international banks that have lower capital requirements as they may be able to lend at cheaper rates after the impact of endgame.

Q: Is there a tier of financial institution that you think be affected the most?

A: Based upon some of the rules, it will affect all banks. Banks that are dealing with investments and wealth, trading and market making, they’ll be hit the hardest. Those assets are going to be a problem. Banks with equity from investing in other companies will have to carry capital requirements on those. They might have to hold up to 400% capital on hand for those deals.

For deferred tax assets- right now when you do loan loss allocations, there’s a time difference there. While you’re accumulating loan losses and before taxes are due you have a deferred tax asset. They could lower your DTA from 25% to 10% if you’re a bank that makes $100 billion or more.

Q: Will anyone shutter because of this?

A: That’s a good question. It may make some banks think twice about doing mortgage lending, they may just shutter those operations. It’s already expensive and with this it will be even worse. Banks might just outsource. You might find banks become more restrictive in their small and medium business loans. It will make banks rethink their products and rethink their pricing.

Q: What would these banks shift to?

A: I’ll use mortgage as an example. Let’s say a bank decides they don’t want to do mortgage- even though they might eliminate mortgage as a product they offer, they still might offer options for customers to get one. They could outsource it, sell 100% of their loans, and get out of them. If they go away from mortgage, real time payments technology is coming down the pipeline like FedNow. ACH is working on something similar to where you can have ACH transactions in real time. RTP is probably the next big thing in banking and the products surrounding that. Part of my expertise is in payments so that’s where I think first.

I think for mortgage I can see some banks just deciding that they would rather focus resources on something more profitable. For me, RTP is the next big thing. Also, AI for fraud. As RTP gets bigger, fraud gets bigger.

FedNow currently allows for some very large transfers. If a fraudster can get a transaction approved for something like a million dollars, you’re in trouble. AI is going to help banks stay on top of that in real time.

Q: How could this affect large, publicly traded banks?

A: They can’t eat the cost, so consumers are going to have to take the hit. They’re going to increase costs to keep money for their shareholders. Restrict more products. They may say that, regardless of income, they can’t provide 5% down loans. They will have to look at pricing on products and at open credit lines and bring that into their calculation on product availability and pricing.

Q: Let’s assume Endgame is implemented as is. If I’m a bank worried about these new regulations, how can I restructure?

A: Preparing now on the rate side would be a bad idea because you’d be less competitive with current banks. You want to do this when it actually comes down. Banks could start looking at open lines of credit and figuring out new calculations to assess client risk. Determine how to rate existing customers and build a new scenario around what going forward looks like. You could start implementing those restrictions now but it’s going to take some time to determine how to do this effectively. That’s a significant undertaking to determine who gets to keep their open credit line and who doesn’t. Entire department assessment systems will have to be changed.

They’re going to need help. They’ll need to bring in a team that can come in and do the analysis behind what is the banks impact, what data do they need, perform an analysis, build the plan of cost of what if they do nothing, here’s some ideas of new tests, credit score is beneath X, build a profile. This way you can have a team in the background preparing without losing manpower.

Each bank is different. You’ll need to determine what data needs to be pulled, run a cost analysis of plan implementation, make persona adjustments and identification, and test these platforms extensively. They should be looking at each of these possible scenarios and creating plans that can be executed quickly if these regulations to get put into place, and that will give them a competitive advantage.

Heitmeyer Consulting provides advisory, consulting, and staff augmentation services to the financial services industry. Contact us today to learn more about how to prepare and scale your business for the future.